London's biggest law firms paid generously to secure the brightest young recruits they could this year. Meeting those salary pledges next year will be a lot tougher with revenues from dealmaking expected to slow dramatically.

Many of the U.K.'s top law firms upped salaries for newly qualified lawyers to as much as £100,000 ($120,600) this year to narrow the gap with top U.S. firms in London. But the value of initial public offerings in the U.K. capital, a key source of cash for law firms which advise on these deals, fell in the first half of 2022 to the lowest since 2008. With the U.K. already on the brink of recession, a reckoning of sorts may be coming.

London's top firms and their largest U.S. rivals made "a real mess of the pay scales," Nigel Knowles, chief executive officer of law firm DWF Group, said in an interview. DWF instead decided to offer junior lawyers shares in the company this year, admittedly not an option for the majority of firms that aren't listed.

"If you're heavily reliant on corporate finance, you've not had the sort of work this year that you've had previously so that means that when people leave, you probably won't replace them," said Knowles.

Macfarlanes, one of the London firms that lifted salaries to match better-paying local firms, declined to comment. The five London-based firms that make up the so-called Magic Circle — Clifford Chance, Allen & Overy, Freshfields Bruckhaus Deringer, Linklaters, and Slaughter and May — either declined to comment or respond to requests for comment.

Finding the revenue to cover the spike in salaries without squeezing profitability will be tough, says Nick Roome, head of KPMG legal services in the U.K. One way firms can try and ease the cash crunch is to slim down their payroll and trade up to more lucrative clients, he says.

"They're probably going to do less, narrow their business models towards the super premium activity that can support that sort of cost base," Roome said. "You are going to see some areas of law that they'll decide to stop doing."

That may in turn provide voids other law firms can fill. Top U.S. law firm Skadden, Arps, Slate, Meagher & Flom sees the slowdown in dealmaking as a chance to expand across Europe, says Pranav Trivedi, a partner and head of Skadden's London office.

Global dealmaking fell to $3.5 trillion in 2022, down by almost a third from last year's record activity, due to a cocktail of inflation, higher interest rates and geopolitical woes. Law firms predict a further slowdown in mergers and acquisitions and IPOs next year.

Still, investors will always be looking for distressed assets in a downturn they can snap up cheaply, providing a boon to law firms. Kon Asimacopoulos, a restructuring partner at Kirkland & Ellis in London, says that's just getting started, and will peak in the first half of 2023.

That's part of how law firms will increasingly focus on recession-proof practice areas in 2023. Litigation, insurance, arbitration and restructuring usually see an increase in activity when the mood turns sour — and London is viewed as the center of global arbitration.

Kirkland is already seeing a "material uptick" from distressed companies calling on lawyers to help them restructure, according to Asimacopoulos.

Meanwhile in London, Skadden has started hiring in insurance and regulatory work, as well as for litigation and arbitration. And Manchester-based DWF just completed its acquisition of Whitelaw Twining Law, which specializes in insurance litigation this month.

Multinationals will also be under pressure to cut costs by reducing the number of firms they retain. Companies that have recently refreshed their legal roster have tended to reduce the number of law firms while expecting greater reach from those they keep, said Knowles.

"You've either got to be super niche or you've got to be global," Knowles said.

Irina Anghel reports for Bloomberg News.

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